Home Financial & Banking Terms What is Prepayment Penalty?

What is Prepayment Penalty?

Prepayment Penalty

When a loan is borrowed, interests and principal are paid periodically until the scheduled payoff date. Sometimes due to various factors we tend to repay the entire loan that was borrowed, including the interest earlier than our scheduled payoff date. For this the lender or the bank will impose a penalty fee on us, which is called Prepayment Penalty. It is also termed as brokerage cost.

In simple words it can mean that if we try to pay off our loan before the stipulated time, we may have to pay extra charges for it.

How much does a penalty cost you?

Payment penalties differ from one loan lender to another. Generally it is derived using the following key factors:

Percentage of loans that we are paying as a whole.
Rate of interest of the loan that we borrowed.
Some lenders fix a flat fee for penalty.

Penalties can also change often with respect to increase or decrease in the rate of interest of the borrowed loan.

What are the types?

Prepay penalties can be of two types – soft prepayment penalty and hard prepayment penalty.

Soft prepayment penalty - Allows the borrower to sell the entity for which the loan was claimed, without any penalty fee. But if the entire loan is being repaid before the tenure, then they impose a penalty over the borrower.
Hard prepayment penalty - Here in both the case you will have to account for the penalty fee.